Critics of Osborne’s new pension rules are talking complete nonsense

Subject to consultation, from April next year anyone who wants to take their whole pension in cash at 55 can. 25% of that will be tax free (as now) and the rest will be taxed at whatever the pension holder’s marginal income tax rate is (subject to the lifetime allowance limits of course – see my blogs here and here, and James Ferguson on the matter in this week’s magazine).

Peter Hargreaves of Hargreaves Lansdown called this the “most important pension news ever”. The Institute of Directors was with him. They called it the “most radical reform to pensions in decades.” And that’s not really an over the top interpretation.

It is, I think, really fantastic news for long-term savers. However, a good many people found an immediate problem with it. De Vere group, a provider of “specialist global financial solutions” calls the new deal “dangerous, ill conceived” and “short sighted.”

NOW: Pensions said that giving savers “complete freedom” in this way is “throwing the baby out with the bathwater”.  And today, even the FT’s Tim Harford, who I like to think of as one of the most sensible men in money media, pointed to a future in which the papers would “wring their hands about some poor pensioner who blew his retirement savings on a boiler-room scam”.

The whole thing, say the critics, smacks of moral hazard: people will get their pension tax breaks, grab their money at 55, spend the lot and then expect the taxpayer to pick up all their bills from then on in.

This is nonsense. Complete nonsense. A few reasons: first, anyone who has saved up a reasonable amount in their pension would have to pay a whopping amount of tax if they took it all at once.

Say they had £400,000 at 65. £100,000 comes out tax free, the rest is taxed at the marginal income tax rate. So you’ll pay some at 20% but the vast majority at 40% or 45%. The total bill? £121,000. Who’d want that? Much better to stagger the take and pay more tax at 20% (or nothing) and less at 40%.

Let’s say you take £40,000 a year for ten years instead (I’m assuming no other income, no inflation and no returns, just to make the point). In the 2014/15 tax year your bill would be £6,000 and the total over ten years would be £60,000. Make it £20,000 a year over 20 years, and the total bill is down to less than £40,000.

Those who hold pensions aren’t idiots, likely to turn from diligent believers in the future to spendthrift short-termers on the turn of 55. They’ve saved this way to save on tax despite the disadvantages, so why would they abandon that principle now?

There’s more. Leaving your money inside your pension and taking it out as you need it means that your investments continue to roll up income tax and capital gains tax-free. That’s an amazing perk, and no one with half a brain – or in contact with an adviser with half a brain – would chuck it away lightly.

Let’s not forget that everyone is now going to get “guidance” before they choose a pension option*. Assuming it is good guidance, everyone but the truly desperate (or very unwell) is going to choose to enter flexible drawdown – keeping their money in a pension wrapper and using it to create an income. Note that the new system won’t limit the amount you can take out every year in the same way the current one does.

There are going to be some people who abuse the new system, but that won’t represent change: they are ones attempting to abuse it via pension liberation at the moment. For the rest of us, flexible drawdown and a new pension independence is about to become the norm. It won’t be long before we all think of pensions as nothing more complicated than a long term tax efficient savings account. And who wouldn’t want one of those?

*This is brilliant news by the way. Just-in-time financial education is the only type proven to work. See my blog on it here  – one day I hope we will get the same guidance before buying a mortgage or a loan as well.

  • Tax slave

    Right on Merryn. A refreshing and sensible move away from the nanny state, and may get people back to being interested in saving for their own future, rather than relying on state handouts. Well done George! There will of course be howls of dismay from the cosy and bad value annuity bandwagon. George, pity you didn’t find the courage to tackle the inequities of the Stamp Duty threshold market distorters and the CGT without time or inflation attenuation.

    Tax Slave

  • Greg

    But won’t these changes simply stoke up demand for buy-to-let and hence property prices – as if house prices weren’t high enough already? …and surely a secure income from an annuity is better than riskier income from buy-to-let?… and there’s the risk people could end up spending their pension pots and end up relying on the state for support!

  • Greg

    I think you assume everyone is a canny and responsible investor, Merryn – but we’re talking about the retired and the elderly – they will no doubt get the wrong advice and make mistakes…

  • PDL

    The 25% tax free might find its way into buy-to-let, but that’s true now. As Merryn says, the tax cost of of taking huge amounts at once is prohibitive.

    And anyone who has built up a decent sized pension fund probably is “canny and responsible”.

  • mr clyde

    …and then there is IHT – If pension income is only vested and drawn down as it is needed, then currently the rest of the fund stays outside your estate for IHT. If the 75 yrs age limit is abolished then, in theory, you could carry on drawing down an income until you die with the remainder staying IHT free. In effect Osbourne has just increased the IHT allowance to a potential £1.575m. Has he realised?

  • brownsfriend

    100% in agreement Merryn. Just coming up to make decision re drawing down retirement pot- form was ready to be sent to James Hay- what luck eh! Annuities never even considered ( IMHO would not ever get money back). Now I can take out what I need each year while staying invested until the grim reaper appears. I can estimate tax position as each year progresses and withdraw accordingly. Would never consider buy to let – hassle,all eggs in one basket and you cant access investment when needed. I can front load withdrawal if necessary as I want to spend now while fit and active not when I am dribbling in an armchair in the OAP home!

    • brownsfriend

      Its the newly retired making decisions about how to structure retirement income – people in their 60s mainly – they are generally not stupid and have got to this stage in life with a good pension pot by making good decisions. If required they have probably got good advice in the past and researched their options thoroughly.Condescending nanny state comments about the retired and elderly are just not appropriate. In my experience they are more able to make good decisions than most!

  • TJ

    Spot on Merryn. If we can’t trust pensioners, who have in the past made the long sighted decision to save for their pensions, with their own money who can we trust?

    Not allowing people to control their own money due to worries about an inflated housing market is very short sighted. Clearly the problem is not enough houses being built, not the fact the people want to invest in housing. Also can not imagine many pensioners’ idea of retirement involving becoming a landlord.

  • robertop

    It may be useful to look at the expereince of the R of Ireland which has had similar rules for several years. See
    Several interesting aspects:
    Most people cannot access a sum equal to 10 times the maximum rate of the State Pension (Contributory) – €119,800 at present – until aged 75.
    One is deemed for income tax purposes to have drawn down 5% of the balance annually.
    Further study of the Irish system may help to forecast developments in the U.K.

  • wiseoldman

    Hopefully the big insurers like PRU will see an oppportunity here to offer an attractive product based on the new provisions and replace or supplement annuities with a flexible pension drawdown scheme but with the protection of their investment management resources. This will appeal to those who are less financially astute or simply don’t want the hassle of managing the investment and drawdown of their pension fund. Maybe a combination of annuity/flexible drawdown. Yes there are risks and costs involved but no more than any other form of investment and there is a trade off between risk and flexibility. Better to stick with these companies than fall into the hands of the predators who will be out there to take advantage of the vulnerable.
    No doubt there are meetings going on at these companies right now to decide how to respond and make up some of the profits they will lose from the reduction in annuity take-up.

  • KMS

    interesting comment by MSW & some good replies but I would query Mr Clyde’s
    remarks re IHT.I understand that if the pension pot is untouched at death ( under 75 years) then the pension pot is outside the estate for IHT but if the 25% taken or some income draw down has been made then it is taxable at 55%.
    So not as Mr Clyde suggests
    maybe somebody from Money week can clarify ??

  • Leothegas

    “Subject to consultation”; One hopes that the 3 yearly review and its costs will also be thrown into the long grass now that the majority of us will chose some sort of flexible no limits drawdown plan? So a drop in revenue isn’t only going to hit annuity providers.

  • PJG

    Recent history tells us that when someone offered the choice between a small amount of regular income and a significant lump sum will usually take the lump sum.
    eg If you have a choice of £30,000 or £140 per month people will chose the £30,000.

    Recent experience of endowment misselling compensation is that people spend such lump sums on holidays and new cars.
    Anecdotally this has already started to happen – having heard of a man going through annuitisation who has stopped the process because someone has offered to sell him a boat!

    • 4caster

      I thoroughly agree. This is an electioneering stunt by a desperate man. Most newly-retired pensioners underestimate how long they are going to live. Many with modest pensions will thank George Osborne for the chance to take the holiday of a lifetime or buy that boat or car or join the housing bubble. Osborne will not long be gone before they start scrounging from the state.

  • Merryn

    @robertop – thanks for the Irish reference. Useful. There has been a similar system in Australia and v few people take the lot there. @PJG you might be right but my guess is that as in Australia, when people understand the tax situation – it is really just a pension liberation tax cut from 55% to 45% or 40% if you take it as a lump sum – they won’t be so quick to take the lot as a lump sum.

  • Merryn

    Useful link on the Australian situation here They’ve had this kind of pension freedom since 1992 but with no real problems. “Do Australians blow their super pots when they reach retirement? The answer is no they don’t,”

  • Woodberry

    Writing as an elderly (well over 65) and retired pensioner I am now better informed about these matters than I was when I was working. I made investing mistakes then and I make them now. But my hit rate of good ones has gone up.

    Hopefully the next thing to be tackled will be the 55% rate on the balance of the remaining SIPP when its owner dies. As I understand it this is unavoidable – it doesn’t fall into your estate where the effect could be mitigated by the IHT threshold or the option of making gifts to charity.

    This creates a perverse incentive to spend the lot as quickly as your marginal tax rate will allow. Yet the sensible thing from the community’s point of view is to encourage pension pot holders to take out as little as they need so that they have a reserve pot as insurance against possible care costs.

  • occasional ranter

    Woodberry – yes, the consultation paper promises a review of that 55% rate precisely because of the perverse effect on behaviour that you describe.

    Leothegas – yes, 3 yearly reviews and all associated bureaucracy should disappear at the same time.

  • Merryn

    On the much discussed matter of people taking all their money as a lump sum regardless of the tax implications. It is worth remembering that you can already take your money as a lump sum if you want – you just have to pay 55% on it. That’s enough to stop almost everyone doing it. So why should 40% or 45% make that much difference as a barrier?

  • occasional ranter

    Merryn – agreed. Assuming that the rules will still require members to “crystallise” £75 of funds as taxable pension/lump sum for each £25 of tax-free lump sum, then I think what will happen is that the currently exotic “phased flexible drawdown” will become the standard form of drawing benefits, i.e. each tax year you decide how much in total you want to draw from your pension pot and you “crystallise” that amount only (25% of it tax-free, 75% taxed at your marginal rate), leaving the rest “uncrystallised”. That avoids the 55% tax charge, or whatever rate it becomes, on lump sum death benefits if you die before 75.

  • Paul Islington

    What amazes me is that nobody has ever drawn a comparison to the US model of 401k… Past the age of 59.5 y/o, the funds can be accessed through standard drawdown and/or annuity – all of it being subject to income tax, as a normal income would.

    This system has been around for years and years, and tens of millions of americans are using that system every day.

    Maybe we should try to avoid reinventing the wheel and crying for wolf, and start collecting data point from their experience. I am not sure Lamborghini sells more cars per retiree in the US, than in the UK…

  • 4caster

    Small pension pots may now be taken in cash, rather than having to be invested in annuities. This may provide a new opportunity in Immediate Vesting Personal Pensions (IVPPs).

    IVPPs are available for anyone below the age of 75, and are particularly advantageous when vested in non-taxpayers, including children and income-poor pensioners.

    The IVPP investor can pay up to £2,880 per fiscal year. HMRC grosses this up by the basic rate of tax, whether or not the investor is a taxpayer, adding £720 to make £3,600. Higher rate taxpayers can even reclaim an extra tax refund.

    The vestee can immediately draw a lump sum of 25% of £3,600, i.e. £900.

    That leaves £2,700 in the Personal Pension. Previously this would have to buy a small annuity, meaning it would take some decades to recover the £2,700. But now pension pots of this size can be taken immediately in cash, i.e. the whole £3,600 can be withdrawn, making an instant profit to a non-taxpayer of £720, the HMRC contribution.

    Naturally the pension provider would want to cream off some profit, because the previous means of making a profit will be denied to the company, specifically the opportunity to make outrageous charges on the annuity.

    But with online applications and automation from start to finish, the expenses of running the service could be very low.

    First of all, have I understood this correctly, and secondly, is anyone aware of any plans to run such a scheme?

  • CKP

    I broadly agree with the new liberal rule changes but inevitably a large scam industry will emerge to dupe pensioners into withdrawing huge sums from their pots and handing it over for dubious investments/savings. There needs to be strict enforcement and harsh punishment for those seeking to defraud the elderly and vulnerable of their hard earned retirement cash.